European investors eye substitutes for sovereign debt

The prospect of falling government bond yields has institutional investors considering their options, according to Allianz Global Investors' latest survey.

December 05, 2012

The fear that government bonds’ low interest rates and meager yields are here to stay crept into participants’ responses to the fourth RiskMonitor survey – Under Pressure, published today by Allianz Global Investors.

The survey was conducted in October 2012 by Allianz Global Investors and Investment and Pensions Europe. It gathered responses from 155 institutional investors with a total of 1,934.5 billion euros of assets under management or advice. The survey targeted institutional investors in Austria, France, Germany, Italy, the Netherlands, Switzerland, the United Kingdom, Denmark, Sweden, Finland and Norway). While the RiskMonitor is not representative, it carries enough weight to outline important trends among institutional investors in Europe.

Current interest rate levels are clearly the greatest worry to European institutional investors and, in their wake, the fear of financial repression trounces most other macro-economic issues such as the potential slowing of Chinese growth or the much publicized U.S. fiscal cliff. The specter of repression keeps a quarter of respondents awake at night, while America’s year-end dispute over spending cuts and tax hikes and China’s growth outlook worries only 10.5 percent and 5.9 percent respectively.

Concern over interest rates is particularly high in France, Italy and the German-speaking countries.

The alternatives are evident to most investors: Corporate bonds are considered a suitable substitute by more than two thirds of the survey’s respondents. Emerging markets debt (37 percent) and real estate (31.2 percent) come in second and third, followed by covered bonds (22.7 percent). Infrastructure debt (13.6 percent), infrastructure equity (13 percent), private equity (10.4 percent) and commodities (5.8 percent) are other alternatives named by respondents.

With particular regard to Asia, the survey states that three in five investors expect to raise their exposure to benefit from the region’s strong fundamentals. Yet emerging Asia is viewed with a healthy skepticism, particularly by Dutch and Nordic investors who often point to a lack of transparency. “Changes in the legal system are necessary to make this region more popular,” says one Dutch asset manager.

But not everything is bleak: Far fewer respondents consider sovereign debt a huge risk. Their number dropped from 35 percent (2011) to 13.2 percent (2012). The declaration of European Central Bank president Mario Draghi that the bank will stand behind Eurozone governments rang true with European institutional investors.

Future finances: 10 riskiest countries

United Kingdom Fiscal Risk Rank: 10 (1/10)

Extreme risk countries have aging populations, low birth rates and weak economic growth, according to risk analysis firm Maplecroft, authors of the Fiscal Risk Index. Pensions and healthcare will need to be provided for more people for longer. Meanwhile, the working-age population is shrinking so governments will have less tax money to pay for pensions, healthcare and education.

In the UK, there are currently 25 old people for every 100 people of working age—an ‘old-age dependency ratio’ of 25%. This is forecast to rise to 38% by 2050. And only 7.7% of over-65s work compared to the global average of 28%.

The UK has some of the most generous pension provisions in the world, spending more than double the global average. Government debt has been increasing steadily from 43% in 2006 to 77% in 2010.
(Source: Reuters)

Japan Fiscal Risk Rank: 9 (2/10)

Japan is deep in the red. It has been hammered by a shrinking economy. It has an average government debt between 2006 and 2010 of 203% of GDP; the highest of the extreme risk countries and third highest in the world.

Aside from a huge deficit, Japan also has a fast-aging population. By 2050 there will be an incredible 74 elderly Japanese for every 100 workers, by far the highest old-age dependency ratio, and only 22 children.

But unlike the rest of the ‘extreme risk’ countries Japan does have a lot of elderly workers. Nearly 19% of over-65s are contributing to the economy, which compares well with the United States at 17.5% and is more than double all the other ‘extreme risk’ countries apart from Sweden.
(Source: Reuters)

Austria Fiscal Risk Rank: 8 (3/10)

Dancers at the Vienna Opera Ball. Austria is aging fast, and like all the other extreme risk nations will have at least one elderly person for every two workers between 2010 and 2050, ending up with 52 elderly people per 100 working-age citizens by mid-century.

What’s especially worrying for Austria is that it spends over 12% of GDP on the elderly, more than any other extreme risk country and the third highest proportion in the world.

On the other hand, by 2050 Austria should have 25 children per 100 adults compared to just about 22 in 2010. And Austria’s GDP growth in the years 2006-2010, although a measly 1.08%, has been better than all the other extreme risk countries.
(Source: Reuters)

Denmark Fiscal Risk Rank: 7 (4/10)

Denmark spends heavily on education, ranking 14th in the world and the highest among the extreme risk countries. The government also supplies the biggest proportion of healthcare costs at 84.7%. It also spends heavily on pensions, putting it in the top ten of Maplecroft’s Pensions Index.

These factors weigh heavily on Denmark’s finances, as will its average old-age dependency ratio of 65 elderly for every 100 working-age people from 2010 until 2050.

The good news is that despite GDP growth since 2006 of just 0.04% per annum, government debt is at a manageable 40% of GDP, making it the most solvent of the extreme risk countries.
(Source: Reuters)

Hungary Fiscal Risk Rank: 6 (5/10)

A Hungarian firefighter at a protest against government cutbacks. Very few Hungarians work after turning 65. It has the fifth-lowest numbers of elderly in the workforce in the world, just 1.8%. And so it spends nearly 9% of GDP on pensions for an aging population.

The government doesn’t spend so heavily on health, picking up the bill for 70% of the nation’s needs, the lowest proportion among the extreme risk countries.

But it nevertheless has debts of over 72% of GDP and a cash flow crisis. Hungary had an annual cash deficit average of -6% from 2004 to 2009, the worst performer among the extreme risk countries and sixth worst in the world.
(Source: Reuters)

Germany Fiscal Risk Rank: 5 (6/10)

Germany will see a severe increase of old age dependency from 31 out of 100 people in 2010, rising to 59 in 2050, the ninth highest in the world. Germany also spends over 11% of GDP on pensions, the fifth highest level in the world.

It will also suffer from a low birth rate, reaching a child-dependency ratio of just 23 children per 100 by 2050, the second lowest number among the extreme risk countries.

To alleviate pressure on the public finances, Germany has recently increased the state pension age to encourage people to work for longer.
(Source: Reuters)

Sweden Fiscal Risk Rank: 4 (7/10)

Sweden will have the highest average old-age dependency ratio—68%--from 2010 to 2050 among the extreme risk nations although it will fall to just 41% by 2050.

Even though nearly 12% of Swedes over 65 do work, Sweden’s generous system means it is in the top ten spenders on pensions, says Maplecroft, and the government picks up 82% of the tab. And like neighboring Denmark, Sweden spends a lot on education.

These are the key reasons for Sweden’s risky position although at present its debt levels, 41% of GDP, are not as threatening as other extreme risk nations.
(Source: Reuters)

France Fiscal Risk Rank: 3 (8/10)

When French people retire they stay retired. France has the second-lowest proportion of over-65s working in the world, only 1.4%. That compares with nearly 12% in Sweden and nearly 19% in Japan.

The old-age dependency ratio will be on average 55 up to 2050, although France will benefit from a higher birth rate than other extreme risk countries, resulting in about 29 children per 100 working-age people in 2050.

France also spends nearly 11% of GDP on pensions, the sixth highest level in the world. Government efforts to raise the pension age have met fierce resistance.
(Source: Reuters)

Belgium Fiscal Risk Rank: 2 (9/10)

A sunbather on the beach at the Belgian coastal city of Blankenberge. Belgium has extremely low numbers of elderly people working, just under 2%, which is the sixth-lowest rate in the world. By comparison, the United States has 17.5% of over-65s in a job contributing to the country’s coffers.

If this doesn’t change it could be a major problem for the public finances because between now and 2050 there will be on average 56 elderly people per 100 working-age citizens.

And Belgium is already in a lot of debt, 91% of GDP from 2006 to 2010, putting it in the top 25 most-indebted countries. Of the extreme risk countries, only Italy and Japan are deeper in the red.
(Source: Reuters)

Italy Fiscal Risk Rank: 1 (10/10)

An elderly lady at the Venice Carnival parade. The most unsustainable long-term finances in the world belong to Italy, according to Maplecroft. The old lady of Europe will have 62 elderly people for every 100 workers by 2050, the fifth-highest old-age dependency ratio in the world.

Less than 4% of the over-65s work and so government pension costs are a whopping 11.6% of GDP, the fourth-highest level on the planet. Even worse, Italy’s economy shrank from 2004-2009 by just under half a percentage point every year, the third worst performance worldwide, leaving the government with debts of 110% of GDP.
(Source: Reuters)